Tuesday, October 20, 2009

Paul Ryan on Inflation

Congressman Paul Ryan has a very accessible and even-handed discussion of the possibility of inflation at The Journal Even though the piece has the ominous title of Inflation's Looming Shadow it is a very measured description of the current situation:
Over the past year, the Fed has more than doubled the monetary base (Figure 2) in order to fund the broad array of programs it has used to try to ease credit conditions in our economy. Some tend to refer to this as the Fed simply “printing money,” but it is important to point out that the lion’s share of the increase in the monetary base is due to a large expansion in bank reserves. This has not caused inflationary pressure because that money is not yet circulating in the broader economy...

Ordinarily, very low interest rates and an increasing monetary base would tend to stimulate borrowing and spending, but the economy appears stuck in a situation that economists refer to as a “liquidity trap.” The standard monetary pumps are primed, but the release valves to the broader economy – the banks – remain clogged.
Ryan then argues why even thought it is not currently a threat, we are right to be mindful of the possibility of future inflation:
As the economy recovers and the normal lending, borrowing and spending channels open up, the Fed will need to start draining these large bank reserves from the system or else severe price pressures will result. In short, to control inflation, the Fed will have to trigger in essence another credit crunch by pulling money out of the banking system, at the very time business lending begins to pick up. But the Fed may be too slow to act or tempted to keep its monetary policy too loose for too long, which could lead to yet another credit and asset bubble.
Be sure to go read the whole thing. Even if you don't usually agree with Ryan or have no idea who Paul Ryan is, this brief description is an excellent tool for understanding our current situation.

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